For the first-time homebuyer, the initials "PMI" can carry about as much dread as the initials "IRS." And what they mean can be about as confusing as the federal tax code.
But learning about PMI - or Private Mortgage Insurance - is much simpler than figuring out your taxes and much more rewarding.
PMI is, literally, an insurance policy on your conventional mortgage loan that protects the lender in case you default on your home loan. It is typically required whenever a borrower makes a down payment of less than 20 percent of the home's purchase price. While PMI adds to your monthly payment, it can also open the home ownership door for those who cannot reach the 20 percent benchmark.
Private mortgage insurance originated in 1957, when a Milwaukee attorney began the first private mortgage insurance company. Seven years earlier, Max Karl had discovered that both developers and mortgage lenders were becoming disenchanted with red tape from the Federal Housing Administration's low down payment mortgage insurance programs. As mortgage lenders began to drop the FHA programs and switch to standard large down payment mortgage loans, home ownership became more expensive just as the baby boom was getting under way.
Karl's new company insured four mortgage loans in its first two months of existence. Since then, the PMI industry has grown significantly and has helped 20 million Americans buy homes with lower down payments.
Even if you can't put 20 percent down, there may be ways to avoid PMI. With secondary financing, for example, you may be able to obtain a primary first mortgage loan for 80 percent of the purchase price, and obtain a secondary mortgage for an additional 10 percent, leaving you on the hook for a down payment of just 10 percent. Several variations of secondary financing are available, but secondary mortgage loans usually carry a higher interest rate. Your lending professional should be able to help you determine whether a secondary mortgage loan would cost more than PMI and help find the best solution for your individual situation.
Even if you've got PMI, don't worry - it's typically not something you have to live with for the life of your loan, thanks to a federal law known as the Homeowners Protection Act of 1998, which impacts conventional first mortgage loans closed on or after July 29, 1999, and secured by single-family primary residences.
Under that law, PMI will generally be canceled at your request as soon as your mortgage loan balance reaches 80 percent of the home's original value (that is, the lesser of the sales price or the appraised value at origination) - as long as your payments have been made on time, the lender is satisfied that there has not been a decline in your home's value, and there are no subordinate liens outstanding on the home.
Or, if you don't specifically request that your lender cancel the PMI, the PMI must generally be automatically canceled by the lender when your mortgage loan balance reaches 78 percent of the home's original value, as long as your payments are current at that time.
If your loan was closed before July 29, 1999, you should contact your lender to find out what its policies and practices are for cancellation of PMI. Many lenders typically will permit you to cancel the PMI once your balance reaches 80 percent of the home's original value and some lenders may be willing to base the percentage on the home's current appraised value (provided, in many cases, that you are willing to pay the cost of the new appraisal).
Updated: January 1, 2013
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.
© 2013 Wilmington Trust Corporation.